This is the first of a 5 part series from Mike Konczal, a former financial engineer, is a fellow with the Roosevelt Institute, who also blogs at New Deal 2.0, and is working on financial reform, the 21st century economy, structural unemployment, inequality, risk sharing, consumer access to financial services and more generally what it means to have a social contract in a financialized, post-industrial economy.

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This is a series giving a basic explanation of the current foreclosure fraud crisis: This is Part One. Parts Two, Three, Four, and Five. will all be posted the each day rest of the week at The Big Picture.

The current wave of foreclosure fraud and the consequences for the economy are difficult to follow. As such, I’m going to write a few posts to simplify what is going on so you can follow stories as they unfold. This is very 101 level, and will include a reading list of blog posts and articles at each stage to help provide depth. (Special thanks to Yves Smith and Tom Adams for walking me through much of this.) Let’s make three charts of the chains involved in the process. The first is what is currently going on with foreclosure fraud (click through for larger).

As you can see, in judicial review states like Florida the courts require that servicers, or those who administer the bonds that are full of mortgages (securitization, residential mortgage backed securities, RMBS, are all phrases for them), say that they have everything necessary in order to have standing to bring a foreclosure. They need to have the note for a mortgage, which is supposed to be in the trust – part of the mortgage backed securities – that they administer.

What is breaking down here? In Florida, a judicial review state, it was found that one person was notarizing documents far faster than anyone could reasonably have. Forged documents necessary for the foreclosure process like the note were found. A separate court system was set up to resolve these foreclosures faster at the expense of allowing serious challenges to the documents. Here’s Smith on how kangaroo these courts look up close. Here’s WaPo on one individual and the nightmare of trying to challenge an invalid foreclosure. Keep him in mind when you hear about deadbeats and whatnot: the current system is designed to make it difficult for anyone to challenge their case.

Meet the robo-signer who kicked it off here at this WaPo story. I almost feel bad for this patsy; the real battle here is between junior and senior tranche holders, and this doofus could end up in jail in order to keep John Paulson rich. After reading about this guy I’m asking our elites to take care of their patsies better. (Can we get a Financial Patsy Fordism social contract movement going? If you are going to be a patsy for GMAC, you should be paid enough able to be able to buy GMAC’s services or something.)

Why would servicers do this? One story would be that the more foreclosures they process, the more fees they get, so there is an incentive to cut as many corners to speed through the process as possible. Hence the term foreclosure mills. You can read more about this from Andy Kroll’s excellent work for Mother Jones (start here).

There’s another problem though – what if servicers are behaving this way because the actual notes aren’t in the trust? Let’s go back to the creation of these instruments.

I take a mortgage out at Joe’s Lending, a mortgage originator. A mortgage consists of two parts. The first is the note, or the IOU, which is the borrower’s promise to pay. The second is the mortgage, which is the security, or the lien, or the actual interest.

Joe’s lending takes the mortgage note to a sponsor to turn these mortgages into a bond. The sponsor was often an investment bank like Bear Sterns. Now that investment bank puts an intermediary in between itself and the trust. This intermediary is usually called a depositor, and sometimes there are several of them in the chain.

What’s the worry here? Well many of these mortgage originators were fly-by-night shops, shady enterprises that collapsed the moment they hit trouble. And many of them cut corners and one of the corners they may have cut would have been to send the note to the trust. Specifically, there is worry that many mortgage originators never sent the notes to the depositors. Originators wanted volume to get fees and may not have done all the paperwork correctly. There are a lot of things that have to end up in the trust when I take out a mortgage, things like the note, title insurance, supporting documents. But the note is the most important.

Why is this important? Well the trustees usually sign several certificates saying that they have verified all the documentation in these trusts. Many of these trusts are under New York trust law which is particularly clear and strict when it comes to these matters. With this in mind, tackle these three posts by Yves Smith (onetwothree).

So connect the two together, and you can see why we might have a systemic crisis on our hands:

There are roughly $2.6 trillion dollars in mortgage backed securities. The Wall Street Journal starts to explain how this will be a battle between holders of junior and senior tranches of debt. It also exposes the servicers, which include the four largest banks, to extensive legal liabilities by those who bought these securitizations that were signed off as being properly administered and created.

Katie Porter is an expert who has done extensive research into this area and often blogs about it at credit slips. See the blog posts: How to Find the Owner of Your Mortgage and Produce the (Bogus?) Paper. Porter found that this was extensive in her research, see Misbehavior and Mistake in Bankruptcy Mortgage Claims (“A majority of mortgage claims are missing one or more of the required pieces of documentation for a bankruptcy claims. Fees and charges on claims often are poorly identified and do not appear to be reasonable. The bankruptcy data reinforce concerns about the overall reliability of the mortgage service industry to charge homeowners only the correct and legal amount of the debt and to comply with applicable consumer protection laws”). By rushing the process, unreasonable and excessive foreclosure fees can get applied to homeowners when there may not even be the proper documentation to have the standing to bring foreclosure at all.

So keep these frameworks in mind when you see the debate unfold in the next weeks. It is a problem of systemic risk, and it is a problem for the currently cratered securitization market. It will need to be addressed, the sooner the better. But how?

UPDATE: I forgot to thank Tom Adams, a contributor to naked capitalism, for the help he gave me in understanding the topic in the original article. It’s updated above.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

16 Responses to “Foreclosure Fraud For Dummies, 1: The Chains and the Stakes”

I’ve owned a correspondent mortgage lending company for the last 10 years. I can tell you first hand that most of the unfortunate dealings in this industry happen in one of two places. First there are localized pockets of criminals committing frauds against individual consumers. Secondly, and as indicated in this article, there are huge financial firms who simply do not act responsibly.

In this article the front-end origination process is not fully covered but I want to clarify that smaller mortgage companies such as mine would play a role one step in advance of the “mortgage originator.” For example my company closes a loan in our name, funds the transaction with a warehouse line of credit, and delivers the original documentation to the appropriate party (note goes to investor such as BofA, mortgage to the courthouse). If I do not deliver the original note I cannot sell the loan and my company is in deep trouble so you can be sure we get this right every time. What the investors/banks have done with all of these original notes over time is a complete mystery to me.

Does anyone have an idea as to whether this chain of title problem could be come greater with ordinary people, with ordinary pre-RE-bubble mortgages, who are not behind on their mortgage asking for proof that their note is in good standing to simply get out off paying their mortgage?

I thought I’d save y’all some time and trouble by posting executive summaries of the “usual” comments on this topic, thereby freeing you to get on with the more important parts of your lives…

- The banks are a bunch of crooks and should all be fined, disbanded, drawn-and-quartered, and go to jail. The poor homeowners are just trying to make ends meet — not only should they get their houses for free, they should get a big pile of money delivered by forty supermodels.

- The homeowners are a bunch of deadbeats trying to screw the banks by not paying their home loans and should all have their children sold for medical experiments and put out on the street, in the rain or snow if at all possible.

- All parties are innocent dupes of the Forrest Gump Law Firm, who employed dead animated characters from Bevis and Butthead to sign off and forge all the paperwork. They stole all of the notary’s stamps too.

- Because of this, western civilization is about to collapse, and it was all Bush’s (both, either) personal fault.

- Because of this, western civilization is about to collapse, and it was all Obama’s (which is an anagram for Osama, both of whom were born in Slazabotistan) personal fault.

- In any event, Wall Street and the TBTF banks will push through retroactive, double-secret probation legislation pushed through in the dead of night on Christmas that will transfer all property ownership in the United States to Lloyd Blankenfeld who will find a way to cheat his firm and even himself profiting from it.

- And anyway, none if it has really happened. It’s just the media trying to sell more newspapers.

- Anyone who disagrees with me is a complete fool. Anyone who agrees with me is a complete fool too.

The reason the note is important is because without it, or w/o reasonable proof that indeed it did exist, the mortgage is a nullity. The mortgage is a lien against real property securing the repayment of the note. If there is no note, the lien becomes nothing more than a cloud against title. But the fact of a mortgage (filed in the public records) would be powerful proof that a note exists somewhere as well. Combine that with a copy of the note, and a stream of payments according to its terms, and you’d have good proof of the existence and terms of the note. In most courts.

MickRMiller is correct. The notes didn’t get lost with the originators. The originators couldn’t close their own loans. They had to do it through a title company or law firm, and it was usually then the responsibility of the closing agent to get the note to the entity funding the loan. Don’ t think for a moment that you’ll find a pile of unrecorded mortgages and original notes lying around in some defunct originator’s offices. If the note didn’t get where it was supposed to go w/in about three days of closing, I’d be getting phone calls. Same’s true if the mortgage wasn’t recorded in the public records. Notes were treated the same as paper money. Which indeed, is what they are.

Maybe the parrot got a better owner than the deadbeat he had previously:)

Once you are a defendant, you have a few special rights, called discovery; you might want to walk in to your lender’s office, or maybe some other office you have never heard of before but purports to own your house, during normal business hours, and ask to see the documents. If they aren’t there, be sure to take a picture of the clerical person with your phone, it usually stamps a time and date on the file…

Can you be a patsy to more than one master? By diversifying, you personally increase your chances of success.

However in those instances where your lackiness in one venue causes your other master(s) economic harm, your value as a lacky decreases, ergo your and all other patsy’s expected returns, ceteris paribus.

The economic models really get complicated when you allow patsies to have their own patsies.

Recently, the message about the foreclosure mess has changed. Somehow, homeowners are now the bad guys. They are the new scapegoats for the foreclosure mess. Now borrowers who are delinquent on their mortgage payments are being viewed as ” trying to get their home for free without a mortgage.” I believe the focus should also be on the banks and other mortgage servicers who failed to provide the required homeownership counseling, including default counseling, when a borrower was in trouble as is required under their own documents and federal law. I don’t know if the message change is the result of the bank’s p.r. or just confusion caused by information overload. Either way, its troubling.

BoA says they just validated a gazillion foreclosures-in-waiting in a week, so it’s no big deal. Which title insurer agrees? Have any of the mega-title insurers and their re-insurers been on CNBC yet? Haven’t seen ‘em. Why not?

Even if the best Congress money can buy tries to modify/validate all the mortgage processing by instant legislation, and the Prez signs it — after the election, of course — uncertainty over whether the SCOTUS will rule it’s unconstitutional could keep the markets (Wall St. and Main St.) in suspense for quite awhile. That is, unless a much bigger and braver title insurance company than we’ve ever known before rides in on a white horse. [Big Ben, enter stage right.]

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Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

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